Should I Invest in the Chinese Stock Market?

China has gone from being an emerging market to vying for a role as the world’s biggest economic superpower within a few decades, but its growth is showing signs of slowing.

The world’s most populated country has two indices: the Hang Seng in Hong Kong, which the UK ceded control of to China in 1997, and the Shanghai Index.

Boom, bust, boom…

Over the last five years, the Hang Seng Index has performed well. At the end of August 2013, the Hang Seng was at 21,737 but in January this year, it had risen to 33,154 on January 26. It has since fallen back slightly, but was still up at 27,213 on August 17, 2018.

The Shanghai Composite Index, also known as the SSE, is an index of all of the stocks traded on the Shanghai Stock Exchange. On August 30, 2013 it was at 2,098 but peaked at 5,166 on June 12, 2015. 2,668 August 17, 2018. Even though the index is more than 50% below its peak currently, it is still more than 27% above its start point five years ago.

Trade wars and headwinds

The current trade war between President Trump and China is front and centre when it comes to any current economic analysis of China’s position as a trading giant. But there are a number of other underlying issues that are potentially more important to the future of the Chinese economy.

The level of debt underpinning its current position becomes difficult to ignore. The current level of Chinese debt is said by some estimates to be as much as 328% of its GDP, with much of the growth in the Chinese economy funded by State banks or so-called ‘shadow lending’ – where money being lent to companies in China is done so by firms outside of the formal banking system.

Hard to determine actual debt levels

This means these loans are effectively ‘off the books’ and so will not be calculated as part of the known debt mountain supporting the Chinese economy.

It makes it hard as an outsider to appreciate just how perilous the state of the Chinese economy is. But the debt crisis for China is not just internal. Venezuela and Argentina are both thought to have been loaned significant sums by China – in the case of Venezuela in the region of US$60 billion. Since Venezuela is now in a state of collapse, with rampant inflation and citizens leaving the country in their droves, the impact on China from a default on the repayment could be significant.

To cut debt or cut growth?

To deal with this issue, the Chinese government faces a quandary. It either needs to reduce the level of economic growth it expects and deal with some of its indebtedness, or it could be forced into a crisis.

Many commentators expect China to hit crisis point imminently, but whether that happens remains to be seen. The level of concern suggests that anyone looking to invest in China at this stage should consider their options very carefully.

Who are the trade tariff hurting the most?

The ongoing trade tariff war between China and the US will do little to help assuage concerns, and this week a further US$16 billion worth of goods are facing tariffs of 25%. However, the tit-for-tat tariffs imposed by China on US goods is also hurting US companies. Time will tell whether the move hurts Chinese firms more than US business.

No matter what concerns there are about the Chinese economy in the short term, there is little to suggest that it will be derailed from continued growth over the longer term. But there will be volatility, so anyone investing in China should expect that.

Access China’s economy indirectly to potentially reduce volatility

But there are ways to gain exposure to the Chinese market without having to invest directly in the country. For example, there are a number of Chinese firms which are listed on other world stock markets, such as Baidu.

Baidu is a Chinese internet and technology company that is listed on the Nasdaq, but its headquarters are in Beijing. It is the sixth largest company in the world, and is the biggest search engine in China, so its culture and business are immersed in its home country. It is known as the ‘Chinese Google’.

Be creative

Yet you can access its stock on the Nasdaq exchange, which is more developed than any of the indices in China itself and is likely to be less volatile. So, if you are looking to get exposure to the Chinese economy and diversify your portfolio, it may be worthwhile thinking a little more creatively about how you invest. That way you might be able to load the dice a little more in your favour, and reduce the level of volatility you expose yourself to.